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A recent decision of the 4th U.S. Circuit Court of Appeals instructs all bankruptcy lawyers, especially those who primarily represent consumer debtors, that not all educational loans are created equal, at least when it comes to the issue of dischargeability. Virtually every consumer debtor’s lawyer is intimately familiar with the standard imposed in seeking to discharge educational loans made, insured or overseen by a governmental agency. That standard is the so-called “undue hardship” standard first articulated clearly in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987) and later adopted by the 3rd Circuit in Pennsylvania Higher Education Assistance Agency v. Faish (In re Faish), 73 F.3d 298 (3d Cir. 1996). However, not all educational loans are subject to the “undue hardship” standard. Certain loans, made to students pursuing degrees in medicine, osteopathy, dentistry, veterinary medicine, optometry, podiatry, pharmacy, public health, allied health, chiropractic or graduate programs in health administration or behavioral and mental health practice, including clinical psychology, are made pursuant to the federal government’s Health Education Assistance Loan program (HEAL). These loans, authorized by legislation found in 42 U.S.C. sections 292 et seq., have their own dischargeability standard. Specifically, in concluding that a loan made pursuant to the HEAL program should be discharged, the debtor must prove, among other things, that non-dischargeability of the debt would be “unconscionable.” The 4th Circuit’s decision in United States Department of Health & Human Services v. Smitley, No. 02-2056 (filed October 10, 2003) provides interesting insights into the application of the “unconscionability” standard to HEAL loans. From 1983 to 1985, Zane Smitley obtained approximately $27,000 in HEAL loans to finance a portion of his chiropractic college education. His payments were to commence in 1986, but he requested and received a number of forbearances and made no payments during that time. Even after the expiration of the forbearances, Smitley failed to keep his HEAL loan payments current. Smitley’s defaults resulted in the assignment of the HEAL loans to the U.S. Department of Health and Human Services, which negotiated a repayment agreement with Smitley. He did not honor the terms of the repayment agreement, despite the fact that in the years since graduation, Smitley’s income rose to as high as $80,000 annually. In 1999, Smitley and his wife filed for Chapter 7 relief, and received a discharge of over $100,000 in unsecured debt. During the course of the Chapter 7 case, Smitley filed an adversary proceeding against HHS and another educational lender (which was not a HEAL lender). The bankruptcy court conducted an extensive evidentiary hearing at which the court found that during his time as a chiropractor, Smitley had a fire in his office, suffered an injury for which he incurred over $20,000 in medical bills (all of which were paid), and closed his practice due to financial difficulties. Smitley then worked part-time as a carpenter but had not thoroughly explored the possibility of expanding his hours by getting a second job as a carpenter, though he made some efforts to find extra employment as a sales clerk or grocery clerk, a teacher (at the college level only) and a factory foreman. He had not explored the possibility of relocating to another geographic area or undergoing employment counseling. His chiropractic license had lapsed. His wife, who worked thirty-five hours per week, could not work additional hours because of physical problems. The Smitleys had four children, two of whom were 17 years of age. The total family household income was $42,000 and the total amount of educational loans (both HEAL and non-HEAL) was $135,000. After an exhaustive analysis of the family’s income and expenditures and after sending Smitley back to the lenders to ask them for additional consideration, the bankruptcy court discharged both loans, stating that under any possible repayment schedule, the Smitleys would not only never repay the loans in full, they would never reduce the principal due. The court stated that in these circumstances, ” . . . requiring the debtor to continue to pay this debt for the rest of his life, with no hope of a final payment, is unconscionable.” The district court affirmed the bankruptcy court’s discharge order, both on the “undue hardship” standard applicable to the non-HEAL loan and the “unconscionability” standard applicable to the HEAL loan. HHS appealed the district court’s ruling to the 4th Circuit; the non-HEAL lender did not. The Court of Appeals first addressed the standard of review. The case, stated the Court, involved two issues – the meaning of “unconscionable” under 42 U.S.C. 292f(g), and the application of that standard to what the parties agreed were undisputed facts. As to the meaning of the word “unconscionable,” the court stated that this determination constituted a question of law which was to be reviewed de novo, citing In re Ekenasi, 325 F.3d 541, 544 (4th Cir. 2003). Application of the standard to the facts of the case, by contrast, was a mixed question of fact and law which required a “hybrid” review – applying to the factual portion of each inquiry the same standard applied to questions of pure fact and examining de novo the legal conclusion derived from those facts, citing (among other cases) Gilbane Building Co. v. Federal Reserve Bank of Richmond, 80 F.3d 895, 905 (4th Cir. 1996). The court started by stating that Congress had not defined the word “unconscionable,” and thus it was bound by the Supreme Court’s Walters v. Metropolitan Educational Enterprises, Inc., 519 U.S. 202, 207 directive that ” . . . [i]n the absence of an indication to the contrary, words in a statute are assumed to bear their ‘ordinary, contemporary, common meaning.’” It thus started with the dictionary – in this case, Webster’s Third New International Dictionary – and found that the word connotes “excessive,” exorbitant,” “lying outside the limits of what is reasonable or acceptable,” “shockingly unfair, harsh or unjust,” or “outrageous.” The court noted that the 3rd Circuit had construed the term similarly in Matthews v. Pineo, 19 F.3d 121, 124 (1994), a case dealing with discharges of obligations incurred under the National Health Service Corps scholarship program. The 4th Circuit, adopting this “plain meaning,” stated there was little doubt that Congress intended to severely restrict the circumstances under which a HEAL loan could be discharged. In so stating, it cited with approval In re Rice, 78 F.3d 1144 (6th Cir. 1996), the only other circuit court case to have addressed the issue of dischargeability of HEAL loans. The court went on to state that given the stringent, demanding nature of the standard, one more difficult than the “undue hardship” standard, debtors have a heavy burden of proving unconscionability. The court stated that it must view the totality of the circumstances surrounding the debtor and the obligation, examining the debtor’s income, earning ability, health, educational background, dependents, age, accumulated wealth, professional degree, standard of living, whether the debtor’s situation is likely to change, whether the debtor has attempted to maximize income commensurate with the education provided, and whether supplemental income is available. In fact, stated the court, a fact-finder may also consider whether a debtor should even relocate or give up his/her profession entirely to seek alternative, more financially rewarding employment. Also relevant, stated the court, is the amount owed and the rate of interest on the debt. The 4th Circuit canvassed other decisions and noted that a finding of unconscionability occurs only in rare cases. After referring to a number of what would strike most practitioners as compelling cases that nevertheless found against dischargeability, it cited two in which a finding of dischargeability was sustained. One, In re Nelson, 183 B.R. 972 (Bankr. S.D. Fla. 1995), involved a debtor who suffered a nervous breakdown, could not finish medical school, suffered from recurrent major depression with psychotic features and earned only $9.41 per hour. The other, In re Kline, 155 B.R. 762 (Bankr. W.D. Mo. 1993), involved a debtor who had an eight-year-old child, suffered from depression, anxiety, panic attacks, had attempted suicide, had been raped at gunpoint, sexually harassed and abused by her former spouse. In both cases, the bankruptcy courts granting the discharge concluded that the debtor was in essence incapable of functioning in a manner that would allow the debtor to maintain any kind of meaningful job or functioning as a participating member of society. Applying the law to the case before it, a majority of the panel concluded that the strict standard to be applied had not been met. The majority noted, among other things, that the bankruptcy court had not discussed or even defined its understanding of unconscionable, or engaged in any discussion of the relevant considerations. It also appeared to the court that the bankruptcy court did not properly distinguish between the “undue hardship” and unconscionability” standards. Equally important, the court found the debtor to be in good health, had stable employment and, quoting from the bankruptcy court, ” . . . is probably underemployed as a carpenter.” Smitley, the court found, had not diligently pursued additional employment. The court also stated that as a result of the Chapter 7 discharge, over $100,000 of debt had been forgiven and, by virtue of the lack of an appeal, Smitley’s other student loan had been discharged, leaving only a $63,000 HEAL loan (the original loan, plus accumulated charges) as a non-dischargeable debt. The majority concluded its opinion by stating that while it did not want to micromanage the debtor’s life, it believed that the debtor’s expenses were too high (e.g., $1,250 per month for rent, $434 in monthly auto payments, and $100 per month for recreation, clubs, entertainment, newspapers and magazines. Given the “totality of circumstances,” the 4th Circuit concluded, the “shockingly unfair, harsh or unjust” standard required had simply not been met. The court accordingly reversed. One panel member dissented. The dissent did not disagree with the standards which were applied to the facts but rather stated that in reviewing the “totality of the circumstances,” reducing the totality of the circumstances to a list should not make the analysis “some rigid, formula-driven calculation,” since ultimately, the decision to find a loan obligation dischargeable as unconscionable is an equitable one. The dissent then went through each of the factors cited by the majority, and as to each, came to a different conclusion than did the majority, arguing that the majority’s analysis suffered from “fundamental mistakes” – it relied too much on poverty guidelines, and it did not give adequate weight to a factual finding that the debtor had no prospects for increasing income. In addition, the expenses of the debtors were simply not too high. A discharge, the dissent stated, was entirely appropriate in these circumstances. We can learn two lessons (at least) from this. First, not all student debts are subject to the “undue hardship” standard. Second, in this area of the law, reciting the rules may be easy, but applying them to the facts is another matter. As the contrast between the majority and dissenting opinions shows, advising a client that a HEAL loan will likely be discharged in a bankruptcy case is a risky proposition indeed. Myron A. Bloom is a shareholder with the firm of Hangley Aronchick Segal & Pudlin. His practice is concentrated in the areas of corporate organization, bankruptcy, commercial workouts and creditors’ rights.

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